A Whale of a Trade; One Man to Check the Books

One of the “woefully deficient” accounting controls that J.P. Morgan Chase & Co. admitted to in a settlement with the Securities and Exchange Commission on Thursday was having one person in charge of checking the books on the bank’s giant “London Whale” trades.

Jason Hughes, who wasn’t identified by name in Thursday’s settlement, was the bank’s only employee tasked with keeping some of the most powerful traders in the firm honest about how profitable their trades were, according to people familiar with the matter.

The Justice Department has indicted two former J.P. Morgan traders, Javier Martin-Artajo and Julien Grout, for allegedly faking books and causing the bank to make “false and misleading statements” by hiding hundreds of millions of dollars in losses. Mr. Grout’s lawyer said this week his client was a junior employee and had been “unjustly played as a pawn” in the case. A lawyer for Mr. Martin-Artajo hasn’t commented.

In Thursday’s settlement, J.P. Morgan agreed to pay a $920 million fine and admitted the bank had poor internal controls surrounding the giant bets.

The bank’s settlement agreement with the SEC describes the job held by Mr. Hughes as responsible for checking the values traders assigned to 132 trading positions, many of which were complex, hard-to-value derivatives contracts, in order to make sure the bank’s books and company filings were accurate.

A lawyer for Mr. Hughes, who hasn’t been accused of wrongdoing, didn’t immediately respond to requests for comment. J.P. Morgan declined to comment.

The oversight of the traders was “under-resourced,” even though the issue was raised several times between December 2011 and March 2012, according to a separate document filed in the same settlement by the U.K.’s Financial Conduct Authority. The FCA also said that the process “was a highly manual one and therefore inherently susceptible to data entry problems.”

One person was responsible for “all portfolios other than the Asia portfolio,” according to the FCA document. He “previously worked as a trader and had been responsible for marking interest-rate derivatives products, however he had received no formal training in relation to his valuation control role.”

According to the SEC’s settlement, an internal audit found that this person, whom people familiar with the matter identified as Mr. Hughes, often consulted with traders about the value of different positions, even though he was supposed to be checking their valuations.

He said he was checking with traders “to see if they have any market input to decide whether, you know, if it’s, that’s wrong, that’s correct, etcetera,” according to the internal audit as quoted in the SEC settlement.

Prosecutors alleged that Mr. Martin-Artajo and Mr. Grout “took full advantage of the freedom” that bank’s oversight afforded, in the indictment filed against the two men Monday.

Mr. Hughes asked Mr. Grout why he had started to value the trades more favorably, Mr. Grout responded, “talk to management,” according to the indictment and the SEC agreement.

When another employee reviewing the trades asked Mr. Martin-Artajo about the values, he responded that he didn’t use generally accepted accounting principles.

“I’m a trader. I do not mark the books to U.S. GAAP. My job is to manage risk,” Mr. Martin-Artajo responded, according to the indictment.

An internal audit by the bank also found that Mr. Hughes made mistakes when he manually entered information into a spreadsheet that had the “effect of understating the difference between traders’ marks” and market prices by as much as $237 million at one point, according to the SEC agreement.

Even once the bank started to uncover problems with how traders were valuing their positions, those problems weren’t fully shared with bank executives because of “Senior Management’s emphasis on confidentiality,” according to the SEC settlement.

One group reviewing the traders’ positions after problems started to come to light was told not to discuss their work with people outside their group and to “exercise caution in committing its findings to writing.”

The bank admitted in the SEC order that even once executives found out about the accounting problems, bank executives didn’t share the information with the bank’s audit committee.